Federal tax is also known as ordinary income tax. All residents (citizens, permanent and temporary residents) are required to pay this tax. This tax is levied on income from all sources irrespective of their origin. That means even if you had overseas earnings, you may have to pay taxes on those earnings. Tax treaties with different countries govern whether you pay taxes only in the country of origin or both....Show details

The tax rate that is applied on the taxable income is graduated i.e. tax rate increases as the taxable income increases. The taxable income is broken into different tiers, such as 0 - $15,000 as tier one, $15,001 - $35,000 as tier 2, $35001 - $55,000 as tier 3, etc. The tax rate for the portion of income falling in a higher tier is higher from the ones in lower tiers. This ensures that higher earning individuals pay the same tax on lower brackets of their income. These tiers or tax brackets and applicable tax rates are dependent on your tax filing status (Single, Head of household, Married filing jointly, Married filing separately etc).

The Social Security Administration collects a portion of your paycheck in the form of FICA taxes before you get paid. Both the employer and the employee pay a fixed 6.2% each of the employee's gross pay up to $132,900. Self-employed people pay 12.4%....Show details

The employer's tax contribution of 6.2% is also known as Federal unemployment tax or FUTA (Federal Unemployment Tax Act). This tax is used to support the unemployment benefit system. This is more of an Unemployment Insurance (UI) which is a federal-state program jointly financed through federal and state employer payroll taxes (federal/state UI tax). Generally, employers must pay both state and federal unemployment taxes if:

  • they pay wages to employees totaling $1,500, or more, in any quarter of a calendar year. OR
  • they had at least one employee during any day of a week during 20 weeks in a calendar year, regardless of whether or not the weeks were consecutive.
Additionally, there is a fixed 1.45% of the gross that Social Security Administration (SSA) collects for Medicare from the employer as well as the employee. This is a flat tax and unlike Social Security tax, it has no limit. Together Social Security and Medicare taxes are called FICA (Federal Income Contribution Act) taxes. They are collected to support Old Age Survivor Disability (OASDI) and Hospital Insurance (HI). The social security tax is used to pay for OASDI benefits whereas Medicare tax is used to pay for hospital insurance. Learn more on Social Security Benefits.

Different states have different tax rates. Some charge 5%, some charge 8%, and others don't charge any income tax e.g. New Hampshire. State tax is used to fund state programs in various parts of the state and to support the state government staff. If you are not taking standard deduction in your tax return then state tax is deductible for federal tax purposes. This means, that there is no tax on the taxes paid. In case of itemized deductions, the state tax needs to go on Schedule A.

Each city or town has its own financial system to manage the local school system and other public facilities e.g. Police, Fire department, library etc. To support this system, it mainly relies on the taxes paid by the residents. The cities and towns also receive state, and in some cases, federal grants to support town projects. A city/town typically collects property taxes (Real Estate tax on homes/local businesses and Excise tax on automobiles). ...Show details

This tax is based on the assessed value of the property. The annual tax could vary anywhere from 1% of the assessed value to 2% of the assessed value. Typically, it is collected every 3 months. If you have a mortgage on your property this tax is typically paid by your mortgage lender on your behalf. This amount is not taxed in Federal or State taxes to avoid double taxation. So, similar to mortgage interest town tax is deductible for federal tax purposes.

There are 2 types of capital gains. Short Term capital gain pertains to the gain on an investment that is sold within a year of its purchase. The investment could be for a fixed asset such as a real estate property or an investment in the capital markets. The other type, Long Term capital gain pertains to the gain on an investment that is sold anytime after one year and one day of its purchase....Show details

The capital gain tax is capped at 15% (5% for those in the 10-15% tax bracket). Short term capital gain tax on the other hand is treated as ordinary income and taxed at the individual's tax rate. Suppose you are in a 28% tax bracket and you bought the stock of a company for $20,000 on March 7th this year. After seeing it appreciate quite a bit you may be tempted to sell it ASAP. Let's say it goes to $30,000 on March 5th and you decide to sell. In this case short term capital gain tax will kick in and you would be expected to pay 28% of $10,000 i.e. $2,800 as short term gain tax. However, if you had waited for one more day and assuming the stock price of the company you had bought did not change in a day, your tax bill would be just $1,500. So, a little mistake could cost you a lot of money. In case of a depreciable real estate e.g. a rental property, any capital gain over the depreciated amount is taxed at 25%. The reverse of capital gains is the capital loss. For tax purposes, short term loss is adjusted against short term gain and similarly the long term gains and losses. However, in a given tax year you could also adjust a maximum capital loss of $3,000 against your ordinary income in case of no or insufficient capital gain. You could also carry forward capital losses in case they exceed $3,000. The order of adjustment against this $3,000 is for the short term loss first and then the long term capital gain.

With the enactment of EGTRRA - 2001 (Economic Growth and Tax Relief Reconciliation Act of 2001), the dividend tax has been reduced to 15%. This makes dividend more attractive compared to the interest income which is taxed at ordinary income tax rate. If you have money to invest and if you have two investment choices: dividend producing or interest income, make sure you consider different tax rates to make the investment decision. Of course this is not the only criteria.

While speaking of taxes, it is important to highlight tax deferral. You could defer taxes on a portion of your pay by making contribution to various plans e.g. 401(K) retirement savings plan. The amount you contribute under such plans (under certain restrictions) is not taxed. However, qualified withdrawals from such plans (principal or gain) are taxed at ordinary income tax rate based on your tax bracket at a later time. So, sooner or later you always pay taxes on your income. The only exception to this rule is the Health Savings Account . In that case, both qualified contributions and qualified withdrawals are non taxable (including any appreciation).

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